Dear Mr. Berko:

I have $1.2 million and want to open a 1 percent growth and income wrap account at a large brokerage. [Editor’s note: In a wrap account, all administrative and management fees are wrapped into one fee equaling a stated percentage of the account’s assets.] The broker told me that the Securities and Exchange Commission doesn’t approve of wrap accounts, and now his firm frowns on them. Is he telling me the truth? He’s giving up $12,000 a year in guaranteed commissions. Why would his firm discourage this type of account?

T.S., Joliet, Ill.

Dear T.S.:

This man, devoting the same time and effort to a non-wrap account, can generate $40,000 in first-year commissions. So would he want to take your wrap account with a 1 percent annual fee? And he can “churn” another $25,000 to $30,000 next year if he doesn’t wrap your account. So I ask you again: Why should he waste his time with a wrap account and charge you a 1 percent annual fee?

Wrap fees have been a blessing in disguise for most privately managed accounts. Wrap fees of 1 percent to 1.5 percent of an account’s market value have been standard fare in the brokerage industry for 20 years. But, sadly for the brokerage industry, wrap fees have severely reduced stock commissions for most of the large New York Stock Exchange houses. So, no, it’s not the good folks at the SEC who want to eliminate wrap fees; rather, it’s the various brokerage houses that want to put the wrap fee business out to pasture.

The reason is simple: Brokerage firms are infinitely more concerned about the growing dollars in their bank statements than the profitability of your accounts. Be mindful that “revenue” is the real name of this game. Therefore, you must recognize that your broker’s success is measured only by the amount of gross commission dollars he brings into his firm rather than by how well your account performs. If your broker doesn’t generate a specific number of commission dollars a year, he will most likely be fired by the firm.

If you had a $1 million wrap account with a 1 percent fee, you would pay your broker $10,000 a year, and there would be zero commission costs when a trade is made.

A properly diversified growth and income account might have 40 positions averaging $20,000 to $30,000 in market value. And if this were a regular brokerage account, your broker would charge you $25,000 in commission to put those positions on the books. During the next 12 months, the broker might make another 20 trades (that’s 10 sells and 10 buys), which would generate another $15,000 in commissions. That’s at least $40,000 in commissions versus $10,000 in a wrap account. Get my drift?

Most brokerages counsel their salespeople to generate annual commissions of between 4 percent and 5 percent of the assets on their books. Folks at Legg Mason tell me that their number was 5 percent, and before I was fired from Prudential, that firm’s number was also 5 percent a year. A good salesman is trained to generate $30,000 to $50,000 a year in commissions from a $1 million account.

Be mindful that the retail fees on municipal bonds can be 3 percent to 6 percent, GNMA commissions can be 3 percent to 5 percent, limited partnership fees can be as high as 7 percent, over-the-counter stock fees can have markups of 4 percent or more, and corporate bonds, OTC preferreds, new issues, mortgage-backed securities and other investments bring huge, juicy commission numbers to the broker.

Wrap accounts were fine for years because revenues from secondary issues, fees from underwriting, mergers, acquisitions, corporate finance, reorganizations, municipal finance, leveraged buyouts, international finance, consolidations, etc., were bringing in shamelessly obscene sums every quarter. Deal-makers were lighting Cuban cigars with $100 bills, signing $500 lunch tabs and taking private jets across the country to play a round of golf.

Well, it seems this fee business has slowed to a turtle’s pace and now the brokerage industry needs a new source of revenue. So they turn their wrap accounts into higher-commission retail accounts to stem the loss of revenues. So the following is worth repeating: The success of almost every broker is measured by the amount of commission dollars he generates for his firm, not by how well your account performs. And if you have that in your head, you’ve got it in a nutshell.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.

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